Introduction

The opening case illustrates the gains that come from international trade. For a long time the economic policies of the Ghanaian government discouraged trade with other nations. The result was a shift in Ghana's resources away from productive uses (growing cocoa) and toward unproductive uses (subsistence agriculture). The economic policies of the South Korean government encouraged trade with other nations. The result was a shift in South Korea's resources away from uses where it had no comparative advantage in the world economy (agriculture) and toward more productive uses (labor-intensive manufacturing). As a direct result of their policies toward international trade, Ghana's economy declined while South Korea's grew.

This chapter has two goals that are related to the story of Ghana and South Korea. The first is to review a number of theories that explain why it is beneficial for a country to engage in international trade. The second goal is to explain the pattern of international trade that we observe in the world economy. We will be primarily concerned with explaining the pattern of exports and imports of products between countries. The pattern of foreign direct investment between countries will be discussed in Chapter 7.

An Overview of Trade Theory

We open this chapter with a discussion of mercantilism. Propagated in the 16th and 17th centuries, mercantilism advocated that countries should simultaneously encourage exports and discourage imports. Although mercantilism is an old and largely discredited doctrine, its echoes remain in modern political debate and in the trade policies of many countries. Next we will look at Adam Smith's theory of absolute advantage. Proposed in 1776, Smith's theory was the first to explain why unrestricted free trade is beneficial to a country. Free tradeoccurs when a government does not attempt to influence through quotas or duties what its citizens can buy from another country or what they can produce and sell to another country. Smith argued that the invisible hand of the market mechanism, rather than government policy, should determine what a country imports and what it exports. His arguments implied that such a laissez-faire stance toward trade was in the best interests of a country. Building on Smith's work are two additional theories that we shall review. One is the theory of comparative advantage, advanced by the 19th century English economist David Ricardo. This theory is the intellectual basis of the modern argument for unrestricted free trade. In the 20th century, Ricardo's work was refined by two Swedish economists, Eli Heckscher and Bertil Ohlin, whose theory is known as the Heckscher-Ohlin theory.

The Benefits of Trade

The great strength of the theories of Smith, Ricardo, and Heckscher-Ohlin is that they identify with precision the specific benefits of international trade. Common sense suggests that some international trade is beneficial. For example, nobody would suggest that Iceland should grow its own oranges. Iceland can benefit from trade by exchanging some of the products it can produce at low cost (fish) for some products it cannot produce at all (oranges). Thus, by engaging in international trade, Icelanders are able to add oranges to their diet of fish.

The theories of Smith, Ricardo, and Heckscher-Ohlin go beyond this commonsense notion, however, to show why it is beneficial for a country to engage in international trade even for products it can produce for itself. This is a difficult concept for people to grasp. Many people in the United States believe that American consumers should buy products produced in the United States by American companies whenever possible to help save American jobs from foreign competition. Such thinking apparently underlay a recent decision by the International Trade Commission to protect the Louisiana crawfish industry from inexpensive Chinese imports (see the accompanying "Country Focus").

The same kind of nationalistic sentiments can be observed in many other countries. However, the theories of Smith, Ricardo, and Heckscher-Ohlin tell us that a country's economy may gain if its citizens buy from other nations certain products that could be produced at home. The gains arise because international trade allows a country to specialize in the manufacture and export of products that can be produced most efficiently in that country, while importing products that can be produced more efficiently in other countries. So it may make sense for the United States to specialize in the production and export of commercial jet aircraft, since the efficient production of commercial jet aircraft requires resources that are abundant in the United States, such as a highly skilled labor force and cutting-edge technological know-how. On the other hand, it may make sense for the United States to import textiles from India since the efficient production of textiles requires a relatively cheap labor force--and cheap labor is not abundant in the United States.

This economic argument is often difficult for segments of a country's population to accept. With their future threatened by imports, American textile companies and their employees have tried hard to persuade the US government to impose quotas and tariffs to restrict importation of textiles. Similarly, as the Country Focus illustrates, the Louisiana crawfish industry succeeded in persuading the government to limit imports of crawfish from China. Although such import controls may benefit particular groups, such as American textile businesses and their employees or Louisiana crawfish farmers, the theories of Smith, Ricardo, and Heckscher-Ohlin suggest that the economy as a whole is hurt by this action. Limits on imports are often in the interests of domestic producers, but not domestic consumers.